US bond yields may rise to 4% in 2014

Turmoil in emerging market bond markets to continue; neglected pockets of Indian equities and 'policy ignition' themes to dominate in New Year

After many years, the axis of global growth is going to shift back to developed economies. The International Monetary Fund expects the global economy to grow by 3.6% in 2014, which would primarily be led by the developed world as emerging markets like China, India and Brazil continue to report slower growth.

Developed economies have reported higher than expected PMIs in the month of November, driven by increase in orders, with the exception of France and Spain. Data emanating from the US has also been more than encouraging.

In the month of November, jobless claims in the US fell to a five year low of 7%. The Eurozone is expected to show moderate recovery in growth at 1.1% in 2014, which would be largely driven by Germany and Italy.

If growth is returning to the developed world, it would also impact financial markets too. As the US Federal Reserve has been hinting, a pick-up in growth and positive jobs data will result in a reversal in monetary policy. The jobs data that came out on 6 December was the last piece of data to be released before the Federal Reserve meeting on 18 December, most economists do not expect the tapering to start in December.

However, the impact of this could be offset by the loose monetary policy stance by the ECB and Bank of Japan. Credit Suisse believes divergent monetary policy would strengthen the US dollar. "Interest rate spreads should thus move in favor of the USD."

It's not just the US greenback that is slated to move upwards in 2014. Emerging bond markets have continued to see outflows in anticipation of the tapering of the bond-buyback programme as the yield differential between EM bonds and US treasuries has narrowed significantly.

The US credit strategist at Bank of America Merrill Lynch, Priya Misra, expects US bond yields to rise to 4% by end-2014 from 2.8% currently. This would make emerging market bonds unattractive, after adjusting for risk premiums.

Strategists believe that a strong greenback and lower current account deficit in the US is negative for Asian equities. However, there are plenty of intertwining themes that are expected to play out.

Thanks to the policy uncertainty several state-owned stocks in India and China have been beaten down as risk premium rose on these, however, with policy uncertainty falling to its lowest levels in recent times, strategists believe that there could be scavenging themes in India (policy ignition themes) and China (beaten down state-owned enterprises).

Bank of America Merill Lynch say that the bloom is off Asia, the brokerage's Asia strategists believe there are pockets of neglect, revulsion and value, of which one of them is the "policy ignition" theme in India.